Ford's U.S. Profits Under Threat

The stock price of U.S.-based automaker Ford Motors has nearly doubled in the last two years. Investor expectations of cash profits from the company have improved over this period on the back of solid performance in the U.S. and aggressive expansion plans in Asia. Ford has increased the sales of its cars and trucks in North America by offering comparatively lower cost, but high quality vehicles and used the profits made in China to fund further expansion in the region. Ford’s performance in China has been nothing short of exceptional in this period – the company has managed to capitalize on the weakness of Japanese car makers in the region and grown its market share by flooding the market with a variety of new models. The company is looking to expand operations in Asia further, with another five factories under construction in India and China. However, Ford’s hot streak might be coming to an end as its profits from North America, which it has been using to fund the expansion in Asia and the recovery in Europe, might be about to vanish.

According to analysts at TrueCar.com, a platform for buying and selling cars, the average transaction price for Ford’s vehicles dropped by 2.3% year-on-year in the month of July. Part of the reason behind the drop in ATP was the rising incentives on offer from the company. Incentives on vehicles for the month of July rose by 13.9% year-on-year, nearly double the industry average incentives on offer. The data is surprising because Ford had been holding back on incentives for its best-selling F-150 series of pickup trucks, as it was looking to manage inventory while its factories get retooled for the launch of the all-new aluminum bodied trucks. So why are incentives from Ford up? There are model specific reasons for this but also the disconcerting influence of a major trend in the U.S. auto market.

In 2013, the sales of Ford’s new sedan Fusion rose by 22%, gaining a lot of market share from Toyota. However, in 2014, consumers have tended to favor SUVs over sedans and the sales of Fusion have only risen by 4.3%. So, in order to jump start the stalling sales, Ford started offering interest-free financing for up to 72 months through the Ford Motor Credit Arm on Fusion. For other models, Ford offered $2,000 discounts and other attractive lease deals.

Used Cars on the Rise

The trend of rising incentives is expected to continue because the car market is being flooded with a rising number of cheaper substitutes for new cars – used cars. Ford Motor’s Credit Arm provides the company’s lease offers. Customers can lease a new Ford vehicle for 2 to 3 years and then return it to the company, which auctions off the vehicles. Most of these cars, which have just come off-lease and have been lightly used, are sent to authorized dealers, where they’ll be available to customers interested in buying a new car but not prepared to pay the full price for it. For these customers, these used cars offer the best deals. Over the last two-and-half years, the supply of used cars has been rising as the number of cars coming to the end of their lease programs has risen. The reason behind the rising number of used cars is the high percentage of cars leased in new cars sold. As the car market grew by 13% in 2012 and 7.6% in 2013, the number of vehicles leased also grew. Most of these vehicles are now coming to the end of their lease programs and will soon be added to the supply of used cars on offer at authorized dealers. As the supply of used cars has gone up, their prices have come down. Consequently, automakers have had to cut the prices of their new vehicles in order to remain competitive with the used car market.

Why Does this Matter for Ford?

As stated earlier, Ford has been reinvesting most of the profits made in Asia in aggressive expansion efforts. Meanwhile, Ford has been trying to return to profitability in Europe. The company has lost nearly $3.5 billion in the continent in the last two years. It should be a while before operations in Asia and Europe start trickling down to Ford’s bottom line. As a result, Ford has been heavily dependent on its North America operations for profit. As the chart below shows, Ford’s North America division was more profitable than the entire company on a pre-tax basis in the latest quarter. If incentives on new cars keep rising, the average transaction prices will fall and cause the company’s profitability to decline.

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